Economic Outlook

The UK economy remains challenging as we enter 2024, with persistently high inflation and stagnant output. However, the backdrop will improve in the second half of the year, leading to a recovery in 2025.

Key Takeaways

1. Inflationary pressures will continue to ease in 2024, driven by further decreases in energy and goods prices, along with softening wage growth and service inflation due to labour market slack. We expect inflation will reach the Bank of England’s 2% target by early 2025.
2. Reflecting elevated inflation rates, the Bank of England increased its base rate by 500 basis points in the two years from mid-2021. However, since the second half of 2023, UK rates remained unchanged at 5.25%, and we think they have now peaked. In the second half of 2024, the Bank will switch its focus to cutting rates to stimulate future growth. 
3. The labour market will continue to weaken in 2024 as unemployment rises further and vacancies fall. Wage growth will continue falling from record levels as real income growth is realised, easing pressure on businesses’ labour costs.
4. Although the UK economy avoided recession, 2023 was still an anaemic year for growth. In 2024, we expect the UK economy to grow modestly and rebound in 2025, as inflation moves towards target, allowing interest rate cuts that support real income growth.
5. There are risks. Households refinancing at higher mortgage rates will reduce discretionary incomes and, consequently, consumption. Geo-political uncertainties persist, with ongoing conflicts in Ukraine and the Middle East which make energy prices volatile.

Nascent economic recovery expected in the second half of 2024 

The UK economy remains challenged with numerous headwinds. Most notably, inflation remains elevated. Inflation failed to fall as quickly as expected in 2023 and, as a result, the Bank of England increased rates by 175 basis points to 5.25% over the course of the year, the highest level in 15 years. For businesses, the prolonged period of high inflation has resulted in record wage growth and increased labour costs. This, coupled with the increased debt burden, will continue to erode profit margins, reduce investment, and dampen activity. Weak business sentiment is reflected in the UK PMI surveys, and bankruptcies have risen 25% since interest rates began climbing.

The consumer sector has also been hit. Confidence is considerably lower than the long-term average, and spending has been flat. We expect this to continue at least in the first part of 2024, especially as costly mortgage refinancing will remain a drag on the economy. However, we expect inflation to continue to fall in 2024, partly due to lower goods prices.

As inflation moves towards its target rate, the Bank of England will begin cutting rates. We expect the first cuts in the second half of the year. This will lead to a resurgence in activity from consumers with an increase in real incomes. It will also reduce the debt burden on both businesses and households, further propelling growth.

Apart from the 2% cut to national insurance, no major tax reforms were announced in the Autumn Statement. Still, an election is imminent – the latest it will happen is January 2025, but it is more likely to be in 2024 – and as the Conservatives are currently lagging in the polls, they could introduce policies to stimulate growth in the Spring to enhance their re-election prospects.

Although interest around artificial intelligence is increasing, it remains very much in its embryonic stage. In 2024, we expect companies to start seriously exploring its potential, with gradual adoption and integration into our workplaces taking place. While it should lead to efficiencies and productivity improvements, this is unlikely to feed through for several years. We do not expect to see the large-scale job losses as some are predicting. In fact, in the short-term, there will be employment opportunities in the sector.

Figure 1: Key macroeconomic forecast figures

Source: CBRE Research

Mortgage rollover poses the biggest risk to growth

The ongoing rollover of fixed rate mortgages throughout 2024 poses a risk to household incomes, and therefore our outlook for growth. The UK has 10.8 million mortgages, the majority of which are fixed, and it is estimated that less than half have been refinanced at higher rates. As mortgages shift to higher rates, disposable household incomes fall, reducing their ability to spend, which could result in lower-than-expected consumption and consequently slower growth. The Bank of England’s November Monetary Policy Report estimates that less than half of the expected impact of rising interest rates on GDP has materialised. We anticipate more impacts to emerge, which will continue to weigh on the economy. Evidence from the Bank of England suggests households have already reduced consumption in expectation of refinancing in 2024.

However, many households currently hold excess savings, accrued over the COVID lockdowns. These equate to circa 5.5% of nominal GDP. There is already some evidence that households have rundown their savings. If others follow suit, this could potentially offset the impact of higher mortgage payments.

There are more acute risks to the forecast, especially geo-political threats associated with the ongoing conflicts in Ukraine and the Middle East, which may undermine our assumptions about declining energy prices. However, our forecasts assume there to be no major economic disruptions from current conflicts or other global events.

Commercial real estate more attractive in 2024

Interest rate cuts in H2 2024 will bode well for property yields. After peaking in 2024, these yields are expected to stabilise and compress over the following years, signalling a turning point for values across all sectors. The industrial and retail sectors will benefit from recovering consumer demand as real incomes grow. Prime offices will benefit from a relatively shallow peak in unemployment, as job growth continues to surprise on the upside, particularly in London. The residential sector will benefit from continued strong rental growth, due to the lack of development activity caused by high borrowing and construction costs.

Our synthetic total return forecasts, net of depreciation and non-recoverable costs, indicate that 2024 will be an opportune year to invest in commercial real estate. Some key considerations:

1. Long rates have peaked in 2023 but yield decompression will continue until at least mid-2024, signalling a turning point for values. However, this will vary by sector.
2. The high interest rate environment along with falling values has created a lack of viability for debt buyers and contributed to a thin market; as debt costs fall, this should improve.
3. Equity buyers will benefit from discounted values and based on our forecasts, will be buying at the bottom of the market, benefitting from favourable net total returns.
4. Fewer transactions have made it more difficult to track market pricing. However, as yields decompress further, the mismatch between buyers and sellers will close, with transaction activity increasing throughout 2024. 

Figure 2: UK all property total returns for a five-year Investment (illustrative)*

Source: CBRE Research